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1、1,Rs.,Valuation,Anjana V,2,FOREWORD,How does one value a company?While at a broad level one may be able to understand why a company may be worth a certain amount to an investor or a buyer,it is not always possible to understand why someone is willing to pay a certain amount for a business.,?,?,?,3,F
2、OREWORD,A business worth a significant amount at a certain point in time may suddenly lose much of its value a very short while later.This is what happened in many companies commonly referred to as dot-com companies,which were valued at amounts which may seem absurd now.in hindsight.,?,?,?,4,AGENDA,
3、5,AGENDA,6,BACKGROUND-FAQs,Why do values of companies change from time to time?Does value depend on whether one wants to sell a company,to buy a minority stake or to buy the entire company?Will a strategic investor value a company differently from a financial investor?How can a company which is cont
4、inually losing money have any value?,7,VALUATION PROCESS,Review and selection of the methods of valuationUnderstanding of issues which impact valuation Special situations and their impact on valuation,8,What is value,Cost vs.Market ValueHistorical vs.ReplacementDiffers depending on need of person do
5、ing valuation buyer,seller,employee,banker,insurance company,9,Value to user,Valued because of expected return on investment over some period of time;i.e.valued because of the future expectationReturn may be in cash or in kind,10,Complex nature of valuation,Value A+Value B can be greater or less tha
6、n Value(A+B),11,Why Value,When do you think a company is to be valued?,12,Why Value,ToPurchaseSellTransactTake decisionsReport,13,VALUATION METHODS,14,Valuation methods,These can be broadly classified into:Cost basedIncome basedMarket based,15,Valuation methods,Different experts have different class
7、ifications of the various methods of valuationWithin these methods,there are sub-methodsSometimes the methods overlap,16,1.COST BASED METHODS,17,Cost based methods,Book valueReplacement valueLiquidation value,18,Book value method,Historical cost valuationAll assets are taken at historical book value
8、Value of goodwill*is added to this above figure to arrive at the valuation*We will see how goodwill is valued in later slides,19,Book value method,Historical cost valuationAll assets are taken at historical book valueValue of goodwill is added to this above figure to arrive at the valuationDo you th
9、ink there would be any difficulties in this?,20,Book value method,Current cost valuationAll assets are taken at current value and summed to arrive at valueThis includes tangible assets,intangible assets,investments,stock,receivablesVALUE=ASSETS-LIABILITIES,21,Book value method,Current cost valuation
10、All assets are taken at current value and summed to arrive at valueThis includes tangible assets,intangible assets,investments,stock,receivablesWhat do you think could be difficulties in this method?,22,Book value method,Current cost valuation:DifficultiesTechnology valuation whether off or on balan
11、ce sheetTangible assets valuation of fixed assets in use may not be a straightforward or easy exerciseCould be subject to measurement error,23,Book value method,Current cost valuation:More difficultiesThe company is not a simple sum of stand alone elements in the balance sheetOrganisation capital is
12、 difficult to capture in a number this includesEmployeesCustomer relationshipsIndustry standing and network capitalEtc,24,Valuation of goodwill,Based on capital employed and expected profits vs.actual profitsBased on number of years of super profits expectedMay be discounted at suitable rate,25,Valu
13、ation of goodwill,Normal capitalisation methodNormal capital required to get actual return less actual capital employed Super profit methodExcess of actual profit over normal profit multiplied by number of years super profits are expected to continueAnnuity methodDiscounted super profit at a suitabl
14、e rate,26,Valuation of goodwill,COMPANY ACapital employed:Rs.45 crNormal rate of return:12%Future maintainable profit:Rs.5.5 crWhat would be the goodwill under the normal capitalization method?SOLUTION:(change font colour to see this)=(5.5/.12)45=Rs.0.83 cr,27,Valuation of goodwill,COMPANY BCapital
15、employed:Rs.50 crNormal rate of return:15%Future maintainable profit:Rs.8 crSuper profit can be maintained for:3 yearsWhat would be the goodwill under the super profit method?SOLUTION:(change font colour to see this)=8(50*.15)*3=Rs.1.50 cr,28,Valuation of IA,The value of the IA is from Economic bene
16、fit providedSpecific to business or usageHas different aspectsAccounting valueEconomic valueTechnical valueCan you think of examples of these different values?,29,Valuation of IA,Depends on objective and can vary widely depending on purposeFor accounting purposes to show in financial statementsFor a
17、cquisition/merger/investmentFor management to understand value of company for decision making,30,IA value in transactions,Often value paid in M&A deals is more than market value/book value.This could be:Partly due to over bidding due to strategic reason(existing or perceived)and Partly due to IA of
18、company,not captured in balance sheet,31,Replacement value method,Cost of replacing existing business is taken as the value of the business,32,Liquidation value method,Value if company is not a going concernBased on net assets or piecemeal value of net assets,33,INCOME BASED METHODS,34,Income Based
19、methods,Earnings capitalisation method or profit earning capacity value methodDiscounted cash flow method(DCF),35,Earnings capitalisation method,This method is also known as the Profit earnings capacity value(PECV)Companys value is determined by capitalising its earnings at a rate considered suitabl
20、eAssumption is that the future earnings potential of the company is the underlying value driver of the business Suitable for fairly established business having predictable revenue and cost models,36,Discounted cash flow method,Creame Corner wants to acquire Samosa Specials for Rs.10 million.The net
21、cash flows are in the table below.Creame Corner wants to apply a discount rate of 15%.Should it buy Samosa Specials?,37,Discounted cash flow method,NPV is positive hence based on this method,the answer is YES,the acquisition should be made!Can you think of three deficiencies in this valuation method
22、?,38,Applicability of DCF method,Cash flow to equityDiscount rate reflects cost of equityCash flow to firmDiscount rate reflects weighted average cost of capital,39,Discounted cash flow,Cash flow to equityValuation of equity stake in businessBased on expected cash flows Net of all outflows,including
23、 tax,interest and principal payments,reinvestment needs,40,Discounted cash flow,Cash flow to firmValue of firm for all claim holders,includes equity investors and lendersNet of tax but prior to debt paymentsMeasures free cash flow to firm before all financing costs,41,Discounted cash flow,CF is cash
24、 flow t is the year and r the discount ratei.e.the cash flow for each year from year 1 to year n(which is the timeperiod under consideration)is discounted to arrive at the present valueof future cash flows from year 1 to n,42,Applicability,Discounted cash flow is based on expected cash flow and disc
25、ount ratesSometimes it is difficult to get a reliable estimate for the future and the valuation model may need modification,43,Limitations,Companies in difficultyNegative earningsMay expect to lose money for some time in futurePossibility of bankruptcyMay have to consider cash flows after they turn
26、negative or use alternate means,44,Limitations,Companies with cyclic businessMay move with economy&rise during boom&fall in recessionCash flow may get smoothed over timeAnalyst has to carefully study company with a view on the general economic trends.The bias of the analyst regarding the economic sc
27、enario may find its way into the valuation model,45,Limitations,Unutilised assets of businessCash flow reflects assets utilised by companyUnutilised and underutilised assets may not get reflected in the valuation modelThis may be overcome by adding value of unutilised assets to cash flow.The value a
28、gain may be on assumption of asset utilisation or market value or a combination of these,46,Limitations,Companies with patents or product optionsUnutilised product options may not produce cash flow in near future,but may be valuableThis may be overcome by adding value of unutilised product using opt
29、ion pricing model or estimating possible cash flow or some similar method,47,Limitations,Companies in process of restructuringMay be selling or acquiring assetsMay be restructuring capital or changing ownership structureDifficult to understand impact on cash flow,48,Limitations,Companies in process
30、of restructuringFirm will be more risky,how can this be captured?Historical data will not be of much helpAnalysis should carefully try to consider impact of such change,49,Limitations,Companies in process of M&AEstimation of synergy benefit in terms of cash flow may be difficultAdditional capex may
31、be calculated based on inadequate information or limited data Difficult to capture effect of change in management directly in cash flowAnalyst should try to study impact of M&A with due care,50,Limitations,Companies in process of M&A Historically,many M&As have not done as well as expected.Many time
32、s this has been attributed to valuation being too high.To minimise this risk of over valuation,a proper due diligence review(DDR)exercise is to be done,with one of the mandates for this being careful review of the value drivers and the business proposition.,51,Limitations,Unlisted companiesDifficult
33、 to estimate riskHistorical information may not be indicative of future,particularly in early stage,growth phasesMarket information on similar companies can be difficult to obtain,52,MARKET BASED METHOD,53,Market based method,Also known as relative methodAssumption is that other firms in industry ar
34、e comparable to firm being valuedStandard parameters used like earnings,profit,book valueAdjustments made for variances from standard firms,these can be negative or positive,54,Exercise in Valuation,55,Value estimated,56,Exercise in Valuation,57,Value estimated?,Since multiples differ,this cannot be
35、 used as a dependable guide for valuation,58,Relative Valuation,Using fundamentalsValuation related to fundamentals of business being valuedUsing comparablesValuation is estimated by comparing business with a comparable fit,59,Relative Valuation,Using fundamentals for multiples to be estimated for v
36、aluationRelates multiples to fundamentals of business being valued,eg earnings,profitsSimilar to cash flow model,same information is requiredShows relationships between multiples and firm characteristics,60,Relative Valuation,Using Comparables for estimation of firm valueReview of comparable firms t
37、o estimate valueDefinition of comparable can be difficultMay range from simple to complex analysis,61,Applicability,Simple and easy to useUseful when data of comparable firms and assets are available,62,Limitation,Easy to misuseSelection of comparable can be subjectiveErrors in comparable firms get
38、factored into valuation model,63,VALUATION:What it depends on,64,Valuation depends on,Management teamHistorical performanceFuture projectionsProject,product,USPIndustry scenarioCountry scenarioMarket,opportunity,growth expected,barriers to competition,65,Valuation depends on,Nature of transactionWhe
39、ther 1st round or later roundWhether family and friends or other partiesAmount of money required Stage of company-early stage,mezzanine stage(pre-IPO),later stage(IPO),66,Valuation depends on,Strategic requirements and need for transactionDemand/supply positionFlavour of the season,Initial ballpark
40、valuation can alsobe a deal issue,67,VALUATION:Process,68,Process of valuation,ConsiderNet assets tangible and intangibleFinancial dataHistorical informationCompany infoIndustry infoEconomic environment,69,Process of valuation,Include elements of cash,costs,revenues,markets Plan long term not short
41、haulUse more than one modelDiscount for risks,assign probabilities Arrive at range,A valuation range is preferable to a single number,70,Process of valuation,Finally after arriving at the value rangeraise some fundamental questionsDoes the value reflect the past performance and the expected future?D
42、oes the value reflect the USP as compared to competition?Does the value reflect the quality of the management?,71,Process of valuation,The last mileDoes the valuation reflect the picture you have of the business?Would you be willing to pay this price?,72,Valuation:for investment,Valuation is percept
43、ion in the eye of the beholder It is subject to negotiation,InvestorValue,CompanyValue,Function of time,73,Valuation:in M&A,Value of combined business is expected to be more than value of the individual companies,Value(A+B),Value A+Value B,74,APPLICATION OF VALUATION MODELS In special cases,75,Multi
44、 business models,The entire business is valued as a sum of the parts Valuation depends on successful management of different unitsStrategic decisions usually occur at each business unit levelTo understand the company one needs to first understand the opportunities and threats faced by each business
45、unit,76,Multi business models,Valuation of company that is based on valuation of individual business units provides deeper insightValuation of individual business units also helps understand whether the company is more valuable as a whole or in parts and to understand where the value is(eg.in some u
46、nits or in the company as a whole),77,Multi business models,Particularly useful in restructuring and reworking business and financial strategy of the business going aheadHelps understand and get a better picture of costs of the corporate office and understand allocation of these costs and whether th
47、ese can be reduced,78,Multi business models,Identifying business units can be complexCash flows projection can be complex and interdependent on different units Allocation of corporate office costs and other company costs/benefits may be difficult,79,Multi business models,A business unit is identifie
48、d as one which can be split off as a stand alone unit or sold to another enterpriseUnits are to be logically separableThey should not have depend production/sales/distribution etc.Some joint products may fall under one unit,if there is interdependency which calls for thisIf there is limited interdep
49、endency,this may be viewed by considering transfer pricing and whether transactions could be considered arms length,80,Multi business models,Allocation of corporate costs including some or all of these:Salary and other costs of key management Board costsCorporate administration costsCosts of listing
50、 as a public companyAdvertising and marketing costs,81,Multi business models,Allocation methods are to be carefully thought through and could be a combination of different methods for different costs,includingBased on time spent(time sheets)Advertising based on revenue,82,Multi business models,Benef
